Sukuk: Global Issues and Challenges

Islamic finance is gaining popularity worldwide for more than three decades and demand for Islamic financial instruments is also growing rapidly. Among the Islamic financial instruments, Sukuk has become the main attraction among banks, corporations and customers. Sukuk is the Islamic asset-backed financial instrument issued by Islamic financial institutions according to the Shari'ah.

Although it is commonly referred to as Islamic bonds similar to conventional bonds, they, however, are not the same. Sukuk is not the counterpart of conventional bonds as commonly referred to in many articles. Conventional bonds are interest bearing debt instruments, but Sukuk, on the other hand, are assets-backed financial instruments. Sukuk are not interest bearing financial instruments but rather Sukuk holders have a right of ownership in the assets or properties of the corporation or the issuer (Vishwanath & Sabahuddin, 2009). Interest is forbidden in Islam so Sukuk does not bear interest to the holders, but they have a right to the profit made by the company. Losses are also to be shared among the Sukuk holders and the issuer according to the contract between the two parties.

The basic principle behind the Sukuk is that the holder has an undivided ownership interest in a particular asset and is therefore entitled to the return generated by that asset. The classic Sukuk structure involves an acquisition of a property asset by a special purpose company (SPC). The SPC funds itself by the issue of Sukuk, declaring a trust in favor of the Sukuk holders. The Sukuk holders then receive a return based on the rental income of the asset (Wilson, 2008a).

Sukuk therefore are considered as certificates of equal value that represent an ownership interest in tangible assets. The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) based in Bahrain has issued guidelines that emphasize the differences between Sukuk and conventional bonds. AAOIFI is mainly responsible for formulating and implementing international Islamic finance standards in the market. Currently AAOIFI has issued 85 standards and is supported by 200 institutional members (http://www.aaoifi.com/).

There are 14 different types of Sukuk described as permissible in the AAOIFI Shari'a standard 17 Investment Sukuk. Muhammad Taqi Usmani, Chairman of the Shariah Council, outlines the following differences between Sukuk and the conventional bonds. First, bonds do not represent ownership on the part of the bond holders in the enterprises for which the bonds were issued. Rather, they document the interest-bearing debt owed to the holders of the bonds. Second, regular interest payments are made to the bond holders. The amount of interest is determined as a percentage of the capital and not as a percentage of actual profits. Third, bonds guarantee the return of principal when redeemed at maturity, regardless of whether the enterprise was profitable or otherwise.

Furthermore, the issuer of conventional bonds is not required to return more than the principal and the agreed amount of interest. Whatever profits may have been earned by the enterprise accrue entirely and exclusively to the issuer. So the bond holders have no right to seek a share in the profits beyond the interest.

These characteristics are not to be found in Sukuk. However, many Sukuk in the market today have the same characteristics of the conventional bond. Furthermore, the Sukuk contract must explicitly abide by Shari'ah and that a Shari'ah board must monitor its implementation (Oliver Ali Agha & Grainger, 2009).

The above are a number of issues concerning Islamic finance, ranging from compliance to Shari'ah and more importantly issues concerning financial reporting and disclosures. At present, majority of the Islamic financial institutions worldwide use AAOIFI standards for reporting and disclosures only as a guideline. …

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